Where’s the Inflation? (And Thoughts on Eurozone Sovereign Debt)
In your basic model of the finance world, a pretty sound intuition is that fixed-income investors aren’t going to be thrilled by rising inflation (e.g. see the first line of this post from The Economist). So to this lay reader it seemed a little strange to see EU 10-year periphery bonds trading higher a few weeks ago (ugh, it was finals, sorry) on the news of “the prospect of greater stimulus” from the ECB. Of course, there are good sort of short-term political economy reasons for this; Portugal, for example, is for starters not Ukraine, nor is it a country close to Ukraine, or a country close to Russia, or a country likely to be invaded by Russia, or a country whose economy is dependent on natural gas imports from Russia…
And if you are one of the economies formerly known as the PIIGS/PIGS, it is heartening to learn that the market views your sovereign debt as an attractive place to park funds during a minor flight to quality. But all of this seems to be indicative of the degree to which sovereign bond markets are now influenced by central banks as buyers and sellers in their own right. Yes, ordinarily inflation is bad for bonds, except it’s not if the relevant central bank plans to induce that inflation by…buying lots of bonds. And since nobody seems to expect endogenous inflation from, say, an overheating Eurozone economy, I guess it’s fair to conclude that in the expectations battle between potential ECB-induced inflation eroding the return on sovereign debt and potential ECB-induced bond price rises stemming from a massive monetary stimulus program, the latter won?*
Given all of this, it seems weird that the ECB and other central banks remain as concerned about inflation as they are, especially since neither the Fed nor the ECB has come within a few kajillion miles of their respective inflation targets since about 2010. And markets themselves don’t appear to be expecting massive future inflation – see the (misguided?) discussion above. I suppose a retort might be that markets are only sanguine about future inflation because they know it rates so highly as a concern for central bankers today, even though data supporting its existence looks to have more in common with unicorns than anything else.
But what’s perhaps the most puzzling about the Fed’s (we’ve shifted to North America now, because this is a post that just teems with intellectual rigor) insistence on undershooting its inflation target is that we know how to deal with the consequences if it does so for too long – just ask Paul Volcker (and anyway, would an overheating economy really be the worst economic outcome of the last decade?). It is true that my entire lifespan is more or less coterminous with “The Great Moderation”, so I don’t know what it’s like to get paid in the morning with money that’s worthless by the time I get to the store (What’s that? Nobody under the age of, I dunno, 80 in the Western world has had that experience? And we’re still terrified by the specter of Weimar?), but I am increasingly coming around to the view that perhaps a little more inflation wouldn’t be such a terrible thing, especially if it means there’s a better chance I’ll get hired when I graduate in a year.
*Incidentally, that’s a sincere question mark. Wait, you thought I knew what I was talking about?